Tips for businesses to avoid mismanagement of debt

Many businesses have blamed a challenging economic climate, and load shedding for the failure of business. Forgetting the mismanagement of funds can be the real silent killer.

Frank Knight, CEO of Debtsource says some businesses prepared for the likelihood of tough economic times and survived.

He says there has been an increase in companies getting liquidated, which proves the importance of managing funds correctly.

Consequences of poor management

The rise in liquidation is an indication of poor management, which failed to focus on managing cash flow, reducing debt levels and proper debt management. Businesses need to avoid high-interest-rate lenders and seek better funding options.

He says if a company is not making a profit, then the strategy is ineffective.

Factors like high interest rates and loadshedding can indeed weaken companies, but if the problems pre-existed, such as an ineffective strategy – then these factors will destroy the company, rather than they (factors) being the cause of troubles, he added.

Businesses that are dependent on external loans face potential trouble. Every time the interest rate goes up, even if it is by a small percentage, it means a significant increase in the funding of the company is required just to keep up with the repayments.  

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Mistakes made by managers

He says most businesses often misuse the current cash reserves for long-term projects.

“This practice strains liquidity by tying up short-term funds in assets that require long-term financing.”

What is risky about this approach is if the lenders demand payment before the long-term project yields returns.

Another mistake small businesses make is opting for high-interest loans or invoice discounting to meet immediate cash flow needs. These financing methods come at a steep cost.  

“Another critical issue is the mismanagement of debtors. Companies frequently overlook the true cost of delayed payments from debtors.”

He says when payment is delayed, it translates into additional costs, impacting profitability significantly.

ALSO READ: Finding the right funding option for your small business

Three tips to avoid debt mismanagement:

• Manage debt levels wisely: Go and look at where your debts are within the business and work hard to reduce those debts.
• Focus on profitability over EBITDA: Earnings Before Interest, Taxes, Depreciation, and Amortisation (EBITDA) is a strategy famously critiqued by Warren Buffett because EBITDA might show profitability by excluding interest payments, thereby masking the true financial health of a company. Rather focus on profitability after all expenses, including interest payments, are accounted for as this approach provides a more accurate assessment of a company’s financial viability.
• Safeguard cash flow:  Businesses must meticulously monitor and protect their cash reserves. No business goes under when they have got cash in the bank. Maintaining a healthy ratio between current assets and liabilities is crucial, ensuring that businesses can meet short-term obligations and seize opportunities without jeopardising financial stability.